How should responsible investors secure better boards?

Many in the responsible investment community have cheered the recent shake-up of the ExxonMobil board in the Engine No 1-led campaign as heralding a step-change in investor stewardship practices.

Indeed, a proxy fight over climate where three out of the four dissidents’ nominees were elected would have been inconceivable just a few years ago. The willingness of institutional investors and proxy advisers to support at least some of the nominees does lend credence to the idea that the forceful stewardship many have called for may finally be on the horizon.

Yet, optimism spurred by the Exxon outcome should be tempered by a realisation of how atypical the circumstances that surrounded it were. The unresponsiveness and outright defiance by Exxon in the face of investors’ ESG concerns is rare at a company of its size; more common are placatory statements and high-level commitments to improve by some distant date. The campaign by Engine No 1 was time-intensive, risky and required deep pockets; it would be unreasonable to rely on such long shot campaigns as the primary way to hold boards accountable for ESG issues.

Rather than hoping for activists alone to swoop in and offer them an alternative, institutional investors will instead need to step up their scrutiny of boards’ performance on environmental and social issues and be prepared to challenge ill-equipped boards as a matter of course. Voting against board members and nominating suitable alternatives needs to become a part of investors’ stewardship toolkits.

Shareholder pressure on laggard boards: a mixed bag

While support for shareholder proposals has risen in recent years, voting patterns on director elections has remained more constant. The support for directors at Russell 3000 companies has hovered around 95% for the past few years, while a little over 40 directors this proxy season have failed to receive a majority of shareholder votes. Opposition to directors’ re-election tends to be based on “pure” governance concerns such as board independence, diversity, or overboarding.

Investors have historically been reluctant to hold board members accountable for oversight failures related to environmental or social issues. While BP’s Deepwater Horizon oil spill in 2010 remains one of the worst ESG crises in history, an investor campaign against the chair of the Safety, Ethics and Environmental committee failed to convince a majority of shareholders to withhold their votes. In an analysis of the most common drivers of majority opposition to directors in the US in 2020, E&S oversight concerns did not reach the top 10.

This may be beginning to change with the outcome at Exxon as the starkest instance of this, but it is not the only example. Shareholder pressure at JP Morgan, the world’s largest fossil fuel lender, led to its lead independent director, a former Exxon CEO, stepping down from the board last year. Shareholders at Italian energy company Enel succeeded in appointing a climate expert to its board to support their decarbonisation efforts.

Yet there remains a long way to go. The voting guidelines and policies of many proxy advisors and asset managers make clear that a recommendation or vote against a director on ESG matters will only be considered in exceptional circumstances, generally where a significant oversight failure has already occurred. Aside from potentially slowing progress on systemic risk mitigation, a “wait and see” approach fails to intervene until negative financial, reputational and societal impacts have already occurred. While net zero commitments continue to proliferate, only 0.2% of Fortune 100 directors have specific climate expertise.

Selecting the right tools for the right outcome

What can be done? Investors need to consider how influencing board composition at investee companies sits alongside their other levers for managing ESG-related risks and shaping sustainability outcomes. Shareholder proposals are a key tool to draw attention to specific areas where companies need to change their practices. Yet where the issue in question cuts across a company’s strategic priorities investors should evaluate the board’s expertise in the area and advocate for changes where relevant. Tailored shareholder proposals and improved board oversight of ESG issues is likely a better combination for changing corporate practices than generic recurring advisory votes.

Investors and proxy advisors should re-evaluate their voting policies for director elections. They should consider whether they are adequate to prevent ESG controversies from occurring, and whether they sufficiently position boards to take advantage of upcoming opportunities or sectoral transformations. Investors should proactively assess board ESG competence, particularly at companies that are contributors to systemic risks.

While “just vote no” campaigns can send a strong signal to the board, nominating qualified alternative candidates is likely the most effective method for catalysing change. Events at Exxon demonstrated that coalitions of diverse investors playing different roles can be a route to success. Yet outside of activist campaigns, institutional investors should have a strategy for identifying opportunities where a shareholder nominee could add value. Investors should also consider supporting the nomination of stakeholder groups such as employees to the board, particularly where relevant to ESG risks a company is facing.

Some jurisdictions lend themselves more to this approach than others, and in any case finding, nominating and successfully electing candidates to boards is a resource-intensive undertaking. As called for in Active Ownership 2.0, collaboration will be key.

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